Class Activity

1. Please form a group, which each group will consist of five members
2. For each accounting cycle – your group are required to find a company
that having an accounting scandal or audit issues
3. Identify non-audit services or certain services that statutory auditor or
audit firm is not allow to render

Preconditions for an audit

Once a firm has decided to go ahead with an audit engagement, it must comply with the
requirements of ISA 210, Agreeing the Terms of Audit Engagements. ISA 210 was revised as
part of the International Auditing and Assurance Standards Board’s Clarity Project, with new
requirements to perform specific procedures in order to establish whether the
preconditions for an audit are present.

ISA 210 defines preconditions for an audit as follows: ‘The use by management of an
acceptable financial reporting framework in the preparation of the financial statements and
the agreement of management and, where appropriate, those charged with governance to
the premise on which an audit is conducted’. This means that the auditor must do two
things. First, the auditor must determine the acceptability of the financial reporting
framework to be applied in the preparation of the financial statements. This includes
evaluating whether law or regulation prescribes the applicable financial reporting
framework, considering the purpose of the financial statements, and the nature of the
reporting entity (for example, whether a listed company or a public sector entity). In most
cases this will simply be a matter of confirming with the client that the financial statements
will be prepared under International Financial Reporting Standards, or other national
reporting framework.

Second, the auditor must obtain the agreement of management that it acknowledges and
understands its responsibility:

 For the preparation of the financial statements in accordance with the applicable financial
reporting framework.
 For internal controls to enable the preparation of financial statements which are free from
material misstatement, whether due to fraud or error.
 To provide the auditor with access to all information necessary for the purpose of the audit.

In relation to the final bullet point, if management impose a limitation on the scope of the
auditor’s work in the terms of a proposed audit engagement, the auditor should decline the
audit engagement if the limitation could result in the auditor having to disclaim the opinion
on the financial statements. The engagement should also be declined if the financial
 reporting framework is unacceptable, or if management fail to provide the agreement
outlined above. (ISA 580, Written Representations also requires that management provide
written representations regarding its responsibilities in relation to the preparation of
financial statements.)

Accepting non-audit assignments

It is very common for audit clients to approach their auditor for the provision of additional
services, ranging from audit related services such as tax planning and bookkeeping, to other
engagements such as due diligence and forensic investigations. The audit firm must again
carefully consider whether it is ethically and professionally acceptable to take on the
additional service.

The main ethical threat created by the provision of non-audit services is the threat to
objectivity. The threats created are most often self-review, self-interest and advocacy
threats and if a threat is created that cannot be reduced to an acceptable level by the
application of safeguards, the non-audit service shall not be provided. The UK Auditing
Practices Board’s (APB) Ethical Standard 5, Non-audit services provided to audit
clients contains similar principles, and emphasises the ‘management threat’ which exists
when the audit firm makes decisions and judgments that are properly the responsibility of
management.

Both the Code and ES 5 outline a principles-based approach to determining the acceptability
of a non-audit service to an audit client. With a few exceptions, if safeguards can reduce
threats to an acceptable level then the service may be provided. Safeguards could include
using separate teams to provide the various services to the client, and the use of second
partner review or Engagement Quality Control Review. ES 5 specifies that it is the audit
engagement partner who should evaluate the level of threat, the effectiveness of
safeguards, and is ultimately responsible for the documentation of the acceptance decision.

The provision of non-audit services to audit clients continues to be debated by the

profession. Many argue in favour of outright prohibition as being the only measure which
can totally safeguard auditor’s objectivity. However, it is accepted that audit firms are best
placed to provide audit clients with additional services due to the knowledge of the business
which they already possess, leading to a lower cost and higher quality service than that
would be provided by a different firm. In 2010 the APB issued a feedback and consultation
paper The provision of non-audit services by auditors , which prompted continued
discussion of these issues and recommended a number of measures to:

 Increase the rigour with which auditors assess threats to their independence
 Introduce a new non-audit services disclosure regime and
 Increase the role of Audit Committees in overseeing the retention of a company’s auditors
to undertake non-audit services.
The final bullet point is important as it links to corporate governance. Under many codes of
corporate governance, including the UK Corporate Governance Code , the client’s audit
committee should be involved with any decision as to whether the audit firm can be
engaged to provide a non-audit service. Therefore, when approached to provide a non-audit
service to an audit client, there should be full discussion with those charged with
governance, including the audit committee, with a view to seeking approval for the
engagement to go ahead.

As well as considering independence and objectivity, audit firms should remember that the
fundamental ethical principles apply to non-audit services, just as they apply to audits.
Therefore, when considering whether to provide a non-audit service, the firm should
evaluate its competency to perform the work, whether confidentiality is an issue, and that it
is able to comply with all relevant laws and regulations.

As discussed above, in answering requirements to do with non-audit services, candidates’

answers must apply knowledge to the specific scenario provided in order to score well.